In California, rising pension tide leaves services underwater

PHOENIX -- Rising pension costs mean California cities are increasingly struggling to provide services and beginning to talk uncomfortably about insolvency, according to testimony from city officials and a new report.

Several city officials spoke during public California Public Employees’ Retirement System board meetings in September, offering support to requests from state Sen. John Moorlach, an Orange County Republican, that CalPERS analyze the potential effect of suspending automatic cost of living adjustments temporarily until the fund is stabilized, as well as the impact of moving all retirees into benefit tiers for new hires established by 2013 pension legislation.

The public officials urged the board to work with them to reduce pension costs, and painted a dire picture of city after city struggling to keep the lights on and meet other basic standards due to their pension contribution obligations.

“Corona is struggling with CalPERS rate increases,” said Kerry Eden, assistant city manager and administrative services director for the Riverside County city of 167,000. “Which is leading us to make some very difficult decisions.”

The rate increases have been amplified by CalPERS’ decision to begin reducing its discount rate, which is the pension fund’s assumed rate of return on its investments. The board voted in December to reduce that rate from 7.5% to 7% over a three year period, a rate of reduction some academics and pension hawks still said was insufficient.

It's a zero-sum game; the reduced discount rate means that CalPERS must necessarily increase contributions from a combination of the state, employers, and plan participants in order to avoid slipping even further from its current status of 68% funding.

Corona has already had to make budget reductions to parks and recreation, public safety, and other departments, Eden said, and is actively negotiating with all its employee groups in an effort to offset rate increases. Since 2003, Corona’s annual CalPERS contribution has increased to $23.5 million from $5.5 million. The city now expects the contribution to rise by another $14 million or more over the next several years, she said.

“We are on a path to insolvency,” Eden said, projecting that Corona will exhaust its reserves by 2021.

Officials from other cities gave similar testimony, including Lodi and West Sacramento.

The board never ended up voting on Moorlach’s proposal, which Moorlach on his website blamed on the influence of union interests who testified against his request.

Lawyers have expressed doubt that the options Moorlach asked the board to analyze would be legal, as courts have held that the California Constitution generally prohibits modifying retirement benefits for existing employees. Moorlach wrote that he found the string of testimonies “amazing.”

“To have city managers state that they are facing Chapter 9 bankruptcy and even providing the precise upcoming year they may be filing is a massive disclosure,” he wrote.

An Oct. 2 study by Joe Nation of the Stanford Institute for Economic Policy Research also reinforced the difficult choices local governments face.

The paper, “Pension Math: Public Pension Spending and Service Crowd Out in California, 2003-2030,” looks at a variety of local case studies and their pension situations under scenarios in which pension returns match their targeted rates and in which they come up 2% short. The paper looked at the local pensions administered by the localities, and also factored in debt service on any pension obligations bonds they have outstanding.

“Employer contributions are projected to rise an additional 76% on average from 2017-18 to 2029-30 in the baseline projection and 117%, i.e., more than double, in the alternative projection,” the paper said. “Employer pension contributions from 2002-03 to 2017-18 have increased at a much faster rate than operating expenditures. As noted, pension contributions increased an average of 400%; operating expenditures grew 46%. As a result, pension contributions now consume on average 11.4% of all operating expenditures, more than three times their 3.9% share in 2002-03.”

In case study after case study, Nation’s calculations showed costs expected to rise sharply in the next decade.

In Los Angeles County, for example, 2017-18 pension contributions of $1.5 billion reach $2.5 billion in the baseline projection, and $3.3 billion in the alternative projection where returns fall short of pension fund targets.

In Vallejo, which already filed for bankruptcy in 2008, contributions reach $24.7 million in 2017-18 , which is almost five times the 2003-04 amount. By 2029-30, Nation’s projections show the city’s contributions increasing to $52 million under the baseline projection and $60 million under the alternative projection.

“By 2029-30, pension contributions consume 23.7% of Vallejo’s operating expenditures under the baseline projection, and 27.3% under the alternative projection,” the paper said. That number was just 3.1% in 2003-04, and results in a likely “crowd out” of public services as the city struggles to stretch its resources.

Even under a scenario in which CalPERS expectations about future investment returns are met, the extra budget pressure from Vallejo’s pension contributions would require 24% reductions in police and fire expenditures or more than 8% in across-the-board budget cuts, the study said. If CalPERS investments fall short, those numbers rise to 33% and 12%, respectively.

CalPERS spokesperson Amy Morgan told The Bond Buyer that CalPERS leadership is focused on keeping CalPERS sustainable long-term, and that localities are primarily responsible for benefits.

“We are the administrator,” she said. “The cities and the employers control the benefits. The legislature sets the benefits.”

Nation’s study accounts for all policy changes currently announced by CalPERS and other funds, including CalPERS’ phased-in discount rate reduction.

“There is contentious debate about what is driving these cost increases—significant retroactive benefit increases, unrealistic assumptions about investment earnings, operational practices that mask or delay recognition of true system costs, poor governance, to name the most commonly cited,” wrote Nation, a former Democratic state Assembly member. “But there is agreement on one fact: public pension costs are making it harder to provide services that have traditionally been considered part of government’s core mission.”